Australia

AU Rate-rush buyers head to Struggle St

Borrowing money is becoming cheaper but new home buyers have to loan more to purchase their properties. Thinkstock. Source: News Limited

MAJOR banks warn that buyers spurred into the property market by record low rates may become a new generation of homeowners unable to pay their mortgages when the cycle turns.

With economists tipping that rates will rise next year, and return to the norm above 7 per cent within three years, banks are factoring in a spike in delinquencies on new loans.

Australia's largest home lender, the Commonwealth Bank, and National Australia Bank are among those cautioning borrowers against getting "silly'' due to low rates.

Commonwealth Bank of Australia chief executive Ian Narev said the bank is on guard as low interest accelerates borrowing.

"The key thing we have to bear in mind is a low interest rate environment where people are borrowing, is that when interest rates inevitable go up the loan repayments they have taken on is commensurate with what they will be able to do in a higher interest rate environment," Mr Narev told investors last week.

The warning comes as evidence builds that the RBA's consecutive cuts to the cash rate down to 2.5 per cent is firing up the property market.

Housing finance data last week showed a 13.3 per cent rally over the year to June.

Meanwhile, banks and lenders have moved swiftly to cut home loan rates to between 5 and 6 per cent on the back of the 25-basis-point reduction by the RBA this month.

National Australia Bank chief economist Alan Oster advises new borrowers to consider their future financial viability, before taking on debt in a superficial environment.

"People need to consider the stability of their employment over the next three to four years before taking out a new mortgage,'' Mr Oster told The Australian.

He warns that delinquencies on mortgages could rise in three to four years as home loan rates return to the norm of between 6.5 per cent and 7.5 per cent.

The subprime mortgage collapse in the US was triggered by increasing interest rates, he notes.

For now, borrowers have been handed a gold ticket to capitalise on the rate reductions by keeping their repayments at least constant with what they were before.

Experts advise borrowers to make extra repayments now to give them greater ability to handle any rate rises.

In the initial stages of any loan, most of the repayment goes towards paying off interest rather than the principal. Ramping up repayments from the start is where the real benefits kick in.

Mortgage lenders usually test borrowers' ability to service their home loans using a buffer of about 1.5 to 2 percentage points higher than the given rates. The big four banks also use a minimum lending rate in their calculations to protect against future shocks.

RateCity.com.au chief executive Alex Parsons said borrowers should make sure they can comfortably afford to service their loans if rates increased to the historical average of 7 per cent, and even as high as 10 per cent.

"At current rates, the cost of repaying a $350,000 home loan is $2168 per month, based on the average standard variable rate. But if rates increased to 10 per cent, it would cost an extra $1134 every month to repay the same home loan," Mr Parsons said.

"We typically suggest borrowers commit no more than one third of their income to repaying the mortgage, any more than that and they could find themselves in mortgage stress.

Another factor that could weigh on new borrowers is rising house prices Mr Parsons said while borrowing money is becoming cheaper, new home buyers have to loan more to purchase their properties.

Economists expect the cash rate to remain lower for longer, as the economy softens amid a transition away from mining-led growth.

However, rates can rise swiftly - the standard variable rate went from 10 to 17 per cent in the 1980s. We have crunched the number to show how much more your mortgage could cost when the rate cycle inevitably trends upwards.

COST OF A $350,000 MORTGAGE TODAY

Source: Ratecity.com.au. Calculations based on a mortgage repaid over 25 years, principle and interest

COST OF A $350,000 MORTGAGE WHEN RATES INCREASE

Source: Ratecity.com.au. Calculations based on a mortgage repaid over 25 years, principle and interest